Tuesday, 25 November 2008

An eerie echo of the past

Earlier on I set out how 80 years ago an Austrian economist predicted the ineffectiveness of current efforts to intervene to improve economic conditions.

I have since been directed to an interview with another Austrian economist (this one also a British citizen) that - aside from the poor quality and the stilted voices - could have been recorded yesterday.

In it, Nobel laureate Prof. Friedrich von Hayek explains that inflation is always the result of government action, is the great evil against which we need to battle, and that efforts to intervene to prevent recessions that follow from periods of government-led inflation are doomed to failure.
The part of the inteview from 14.00 minutes to 16.50 minutes is particuarly chilling!

The following is a summary of what he says (I have slightly augmented it with my own understanding of his take on economics, though where possible I have enclosed these additions in square brackets):

  1. Germany out-performed the UK in the three decades after WWII because the German trades unionists remembered that inflation is the enemy of the working man;
  2. If people do not recognise the danger of inflation they will continue to believe that it can be used as a short-term solution to economic problems, as a result of which inflation will continue to wreak havoc upon the economy;
  3. Unemployment results from inflation, which encourages the misdirection of labour [because easy money is made available to enterprises that would not, under normal conditions, be viable, allowing them to offer higher wages than would be possible if the easy money had not been thrown into the system by Government], so it is wrong to suggest that in the long term one needs to tolerate unemployment to curb inflation;
  4. Curbing inflation will cause short-term unemployment, but this need only last a year or so [before the market re-asserts itself and labour is employed once again];
  5. As Jeffrey Tucker notes, the “hilariously naive and idiotic” line of questioning demonstrates how “people really believe that policy makers can manipulate the economy like a machine, trading off unemployment for inflation and back again, with no trouble”
  6. Non-compulsory planning will have no effect and so can do no harm [or, indeed, any good];
  7. “Stopping the printing presses” is a euphemism as the real cause of inflation is credit expansion rather than the actual printing of hard money;
  8. “All inflation is ultimately the problem of activities which government determines and can control. And all inflations have been stopped in the past by the governments stopping creating money or preventing the central bank from creating more money” [thus putting the lie to the government’s suggestion that inflation is caused by outside factors such as rises in the cost of commodities];
  9. A tax cut will not work to stimulate the economy because deficiency of aggregate demand is not the problem. Rather, the problem is that the boom and employment that has been created by the previous inflation can only be sustained by further inflation [which, if perpetuated, would lead to hyper-inflation and ultimately a crisis];
  10. If government continues to inflate to sustain the boom it may have to try to ameliorate the effects by imposing price controls which will lead to the imposition of a planned economy [i.e. socialism];
  11. Political freedom exists hand-in-hand with economic freedom and the former cannot exist without the latter;
  12. The power of labour unions and corporations does not lead to inflation unless that power is used to encourage inflationary policies;
  13. Wages/Prices/Incomes policy is utterly ineffective except as a means of managing in the very short term the period of deflation/restoration;Not all problems are solvable in the short-term and trying to do so may cause more harm than good;
  14. Equities remain a good investment in the long term;
  15. “Inflation is like over-eating and indigestion. Over-eating is very pleasant; so is inflation. Indigestion comes only afterwards and so people do not see the connection”;
  16. Economists are intellectually attracted to the concept of a system that they can control and therefore are instinctively opposed to free markets and non-intervention;
  17. Continued government-induced inflation and subsequent intervention by government will inevitably destroy capitalism [as Karl Marx predicted and hoped for].
Hat tip to Kit for drawing it to my attention, and to mises.org for hosting it.


Joe Otten said...

This is all largely common wisdom these days. I suppose it might be forgotten, and therefore it is worth reminding us. But I don't see a policy of high inflation going on here.

We have had a shock of naturally high oil and food prices, and perhaps such external shocks to inflation should be taken on the chin rather than managed through monetary policy. But this will drop out of the index before long.

When we see a reduction in the money supply because of lenders choosing not to lend so much, it seems reasonable to seek to maintain the money supply (i.e. maintain inflation as close as possible to 2%) with i) lower interest rates, and if that doesn't work, ii) printing money.

Tom Papworth said...

Don't see a policy of high inflation? The Bank of England announced broad-money expansion of over 15% in the last year!

I'm guessing you didn't listen to the radio broadcast, in which he makes it clear that external shocks have nothing to do with inflation, which is (in the words of another great economist) "always and everywhere a monetary phenomenon".

Printing money is irrelevant as hard money has nothing to do with the inflation, while looking to further credit expansion will merely cause further misallocations of resources that will require another correction down the line.

dreamingspire said...

Having experienced both cost inflation and asset value inflation, I suspect that we have more than one cause. The value of houses here has gone up because people within the UK's economy are prepared to pay more for them, which is in turn because of (a) credit expansion and (b) a belief (a bet?) that house prices will keep on rising so the owners will later make a profit (or be able to borrow more against the asset).
Running a manufacturing business (more design and the final assembly than making things from raw materials) in the 1980s I was faced with component suppliers putting up their prices. I asked why, and they said that their suppliers had put up their prices - I was faced with collusion to make more profit, not by overt meetings to fix prices but because suppliers collectively thought that they could get away with it. That was when I realised that markets are metastable. The other side of that metastability is when markets grind down by offering poorer and poorer quality in order to be able to bring the prices down and thus hopefully gain more market share.
Now a great deal of our recent cost inflation appears to have been because oil prices went up. A supplier could have decided not to increase the well-head price that oil sold for - and, more seriously, suppliers of gas could have decided not to follow the oil prices up. The middlemen however took advantage of the fact that there is very little by way of buffer stocks, so the customer just had to pay. And what did we poor end customers (both private individuals and businesses) have to do? We reduced spending on other things as we were forced to spend more on energy supplies, so we contributed to a UK recession as our personal money disappeared overseas. I don't see where UK money supply comes into that as a source of inflation, because credit was still available during the oil price rise.
(And I could make a similar same argument about food prices: shortages leading to price rises - but with a rider that factory gate prices have been too close to or even below the cost of production for too long, and so had to rise to avoid a collapse of supply volume.)
My argument for a third way is that a shortage of buffer stocks is not, in a mature economy, itself justification for price rises such as was recently seen in the oil market - but investment at the supply stage, either in more capacity or in alternatives, does have to be economically viable.

dreamingspire said...

That should have read farm gate prices about food - sorry.

Tom Papworth said...

The relationship between money supply and asset prices is extremely strong. I would refer you to Figure 4 on p60 of Money and Asset Prices in Boom and Bust by Tim Congdon. The European Central Bank also found that “There is evidence of a significant multidirectional link between house prices,
monetary variables and the macroeconomy” (the charts in the report are quite telling, too). Yes people would have speculated on house prices still rising, but that would not have been possible if additional credit was not made available to them. Furthermore, the reason that people speculated was because houses were already rising at double-digit rates due to the double-digit rise in the money supply.

While it is true that rises in oil prices will put up costs for producers and so raise the costs of their goods for consumers, this should not affect inflation if the supply of money remains unchanged. Instead, it will cause a reallocation of resources: the costs of those goods will rise at the expense of other goods, resulting in a shift in demand. Basically, prices will rise, demand will fall, and where demand is inelastic other goods will suffer (e.g. a person may spend more of their money on fuel and less on other things such as services).

It may be that “more of our money goes overseas” if oil rises in price, but you have to bear in mind that the oil producing states do not produce much else. The OPEC nations are largely importers of manufactured goods, so that increases in the price of the oil they export simply increases the cost of the manufactured goods they import. Money does shift around, but within a domestic context it may very well see companies exporting to Arabia benefiting at the expense of companies supplying services to UK consumers. Even if it does lead to a net shift abroad, that is no different than money moving from one sector to another within a domestic economy, and there is nothing that governments can do to stop it (though markets will eventually react as entrepreneurs find more economical ways of using, or alternatives to, fossil fuels).

As for “markets grind[ing] down by offering poorer and poorer quality in order to be able to bring the prices down and thus hopefully gain more market share”, this is simply not true. Quality, like price, reflects consumer demand: quality and price can only be reduced as long as consumers are happy to sacrifice quality for cost, which is why there is a market for both Value milk and Organic milk; Ladas and Lamborghinis; Hugo Boss and Burton. In the marketplace, the consumer is king.

Here's another article on oil Prices and inflation.

dreamingspire said...

Perhaps we have a problem with the different measures of the UK money supply. In the figure to which you refer it is M4, a considerable proportion of which seems to be generated by bankers rather than issued ("printed") by the BoE - and then loaned to us plebs, a great deal of it being used to buy houses - of course asset prices will track this where there is a fixed supply of those assets. Presumably it is M4 that UK banking regulation failed to control - and then it was seen to be not "real money" at all. Indeed, if my supplier put up the price of goods and I could not put up the price of my products, maybe I would borrow more - and so the M4 money supply rises to lubricate this trading.
But on stability of markets, I agree that there will be a correction - but with a time lag. Before the correction, customers who cannot migrate to other suppliers suffer, and that is often the case with business customers. As the market players slide towards lower prices with poorer quality, gradually, a few at a time, customers do manage to migrate to suppliers offering better quality but at higher prices. And in reverse when a market goes the other way, to higher prices. At the personal customer level, my local farmers market is doing very well at the moment because of the quality of the produce, and the producers seem content with the prices realised - a period of stability, but it will eventually slide one way or the other. I think that this fresh food boom for the farmers market is caused by supermarkets actually splitting their market offering: on the one hand cheaper but poorer quality lines, while on the other hand the better quality lines have become more expensive - so the RPI is improving, but the drop is manipulated by changing the quality of some of the goods. (One anomaly: special offer on 5% famous brand lager this week calculates out at 81p per pint.)